The Miracle of Compound Interest

Albert Einstein said compound interest is “the greatest mathematical discovery of all time”. Benjanim Franklin said, “Compound interest is the eighth wonder of the world.”

It’s easy to understand:

When you invest money you earn interest. Let’s say you invest $1000 at 10% interest to keep it simple. The first year you earn 10% so now you have $1100. The next year you earn interest on both your original capital and the interest from the first year. $1100 x 10% In the third year you earn interest on your capital and the first two years’ interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding.

In the first few years compound interest may not seem so miraculous but over time it truly is. With simple interest if you earned 10% a year on your $1000 at the end of 10 years you will have doubled your money and now have $2000. With compounded interest at the end of 10 years you have $2576. That’s nearly 25% more!

Compound interest works best with TIME. If you start young the results mean the difference between worrisome golden years or a happy retirement.

Consider this: Amy, a 22-year-old college graduate, saves $300 per month into an account earning 10% per year for six years. Then at age 28, she starts a family and decides to stay home with the children full time. By then, Amy had kicked in $21,600 of her own money. But even if she doesn’t contribute another cent ever, her money would grow to a million bucks by the time she turned 65.

Compare that to Jason, who put off saving until he was 31. He’s still young enough that becoming a millionaire is within reach, but it will be tougher. Jason would have to contribute the same $300 a month for the next 34 years to earn $1 million by age 65. Although Amy invested less money out-of-pocket — $21,600 over six years vs. Jason’s $126,000 over 34 years — her money had more time to grow, or compound. (Example provided by Kiplinger newsletter)

You aren’t 20, or even 31 you say. If you can’t start earlier then, start today.

Grandparents: One of the greatest gifts you can give a grandchild is to invest $1000 at their birth and let it compound for 65 years – just take care of their retirement for them as a surprise.